Defense Department not comfortable if major contractors look to merge: official

NEW YORK (Reuters) - The Defense Department remains skeptical of mergers involving its major contractors, a Pentagon official said on Wednesday, amid industry expectations that defense deal-making could revive this year.

Elana Broitman, whose office at the Defense Department reviews deals that involve national security issues, told an investor conference that ”there are far fewer of the large firms, so we’re in a more constrained environment.

“Even though we’re seeing a budget downturn which has corresponded to consolidation in the past, we’d be less comfortable now because of that smaller number,” said Broitman, the acting deputy assistant secretary of defense for manufacturing and industrial base policy.

Defense M&A activity ground to a near halt in recent years amid uncertainty about future U.S. military spending that has kept sellers on edge and buyers more apt to invest in share buybacks and dividend payouts than acquisitions.

The recent two-year budget agreement is expected to give some clarity to executives and potentially pave the way for more transactions.

Most experts have been dubious of mergers among the biggest defense contractors - including Lockheed Martin Corp, Boeing Co, Raytheon Co and Northrop Grumman Corp - although they believe the lack of a longer-term budget deal could spark the desire for large-scale deal-making.

Top U.S. defense officials have repeatedly said they are not looking for mergers among top-tier suppliers, but analysts have wondered if deeper budget cuts under sequestration had changed the Pentagon’s view.

Broitman, whose comments came during a panel discussion at Cowen & Co’s Aerospace/Defense & Transportation Conference, said the Pentagon would “review each transaction on its face.”

“We’re not really looking for more consolidation at the prime level, but we will review others as a case-by-case transaction,” Broitman said.

Deals that might raise eyebrows include those that would reduce the competition to one supplier, she said.

“There are areas...in the industrial base where we are down to a single or two smaller-scale companies without which we can’t do a lot of our systems, and we’re not comfortable going offshore for those types of products,” Broitman said.

Asked during the discussion about how the Pentagon would view a private equity buyout, Broitman said, “It’s just not something we’ve focused on.”

However, she later added that a buyout by an equity firm that has foreign investors could prompt a more complex regulatory review.

Northrop Chief Executive Officer Wes Bush was asked about taking the company private during the company’s earnings call last week, but said the company was more focused now on share buybacks and dividend payments.

She also said that while spinoffs from large companies could encourage more competition, “I don’t foresee a lot of just pure spinouts right now unless there are some tax reasons in some cases that make it really attractive.”